Withdrawing the Stimulus
Steve Saville
email: sas888_hk@yahoo.com
Aug 11, 2009
Below is an excerpt from
a commentary originally posted at www.speculative-investor.com
on 6th August 2009.
There has been a lot of discussion
in the mainstream financial press about how and when the Fed
will withdraw the "monetary stimulus" it has provided
over the past year. Also, Ben Bernanke has recently gone into
considerable detail about the methods he will use, once the economy
is on a stronger footing, to gradually remove any excess
money before an inflation problem arises. Unfortunately, these
discussions and Bernanke's detailed plans betray a terrible misunderstanding
about how money-supply changes affect the economy.
Most people who publicly comment on such matters appear to be
labouring under the misapprehension that growth in the money
supply has the potential to cause only one problem: a broad-based
increase in prices. And, therefore, that injecting new money
into the economy will not be a problem until/unless the general
price level begins to rise at an undesirably fast pace. However,
the reality is that growth in the money supply never has an evenly-distributed
effect on the economy; rather, the money enters the economy at
specific points and therefore affects different parts of the
economy in different ways at different times. (As an aside, this
is why monetary inflation is such a popular policy. If increasing
the money supply caused all prices to immediately rise by a similar
amount then nobody could benefit from the inflation, but the
way inflation actually works is that the first receivers of the
new money obtain a benefit, at the expense of everyone else,
by getting to spend the money before it loses purchasing power.
The first receivers of the new money tend to be the government,
the banks, and the supporters and pet projects of politicians.)
In addition to understanding the non-uniform effects of newly
created money, it is important to understand that creating money
out of nothing TEMPORARILY makes it seem as if the economy-wide
level of savings is higher than is actually the case. The result
is lower interest rates and widespread investing in projects
that would never see the light of day in the absence of the distorted
monetary signals.
The non-uniform way in which new money enters the economy combined
with the false impression created by lower interest rates leads
to the large-scale transfer of resources and re-distribution
of wealth. That is, injecting new money changes the STRUCTURE
of the economy, not just the general price level. As a consequence
of the monetary inflation, activities will occur that would not
otherwise appear economically viable and these activities will
collapse once the flow of new money is curtailed. Furthermore,
a lot of the resources that get transferred to these inflation-sponsored
activities will end up being lost to the economy and many of
the businesses that spring up to support the projects that have
been "stimulated" by the money creation will end up
in bankruptcy. In other words, rapid monetary inflation leads
to wastage on a grand scale.
The boom and bust of 2003-2008 is a classic example of what we
are talking about. In response to the rapid monetary inflation
and artificially low interest rates of 2001-2004, many projects
were developed, businesses were started and investments were
made that naturally collapsed during the years after the central
bank tried to restrict the supplies of money and credit. Moreover,
had the central bank not acted to curtail the boom then prices
would have begun to accelerate upward throughout the economy
and a different form of collapse would have eventually occurred.
The main point we are leading to is that the damage done by injecting
a lot of new money into the economy cannot be undone by subsequently
removing money from the economy. With regard to the current situation,
the monetary profligacy of the past year has propped-up many
businesses that should no longer exist and prompted investments
that would not have been viable in the absence of the "stimulus".
These businesses and investments will inevitably fail after pressure
is applied to the monetary brake. And if the central bank refrains
from tapping on the monetary brake then an inflation problem
will emerge that even the Keynesians can recognise.
Steve Saville
 email: sas888_hk@yahoo.com
Hong Kong Regular financial market forecasts and analyses are provided at our web site:
http://www.speculative-investor.com/new/index.html. We aren't offering a free trial subscription at this time, but free samples of our work (excerpts from our regular commentaries) can be viewed at: http://tsi-blog.com
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